Jul 13, 2015

Why Leaders Should Think Like Economists

By Kellogg Insight | Based on the insights of Michael Mazzeo

In strategy, there is always demand for universal frameworks. Business leaders—whether they sell ice cream or microchips—are often tempted by blueprints promising growth in any circumstance. But while certain principles may apply no matter what the industry, the elegance of a single approach can sometimes be an empty promise.

“The strategy field does not provide a silver bullet for CEOs,” says Michael Mazzeo, a professor at the Kellogg School who teaches Competitive Strategy in the executive education program. “It may not be sexy, but the right answer to any strategic question is, ‘It depends.’ Good strategy is always based on a fundamentally economic view of markets and competition.”

For Mazzeo, getting the strategy right means thinking like an economist. “I think leaders are better off with a more systematic, analytical approach. The successful ones have a firm grasp of the underlying economics and how it applies to their industry.”

Understanding Competitive Advantage

So what does a systematic approach call for? First, Mazzeo says, one has to understand exactly what “competitive advantage” means.

“People hear the term everywhere, and they know that it’s a good thing, but we tend to forget what it’s actually describing.” True competitive advantage is based on resources or capabilities unique to a given firm, which makes it important for companies to carefully assess their own profile of assets. “Core competency is not enough,” he says. “You have to be superior to the competition, and you have to understand how that superiority ties into the value proposition you are presenting to customers.”

Once a company has determined what its resources and capabilities are, Mazzeo advises sketching out a Value Creation Proposition—a succinct description of how a company uses these resources and capabilities and how it might leverage them further. “This step allows a company to think about growth opportunities—not just what else is going on in my business, but what am I really excellent at in comparison to the competition?”

Lego is one example of a company that used its traditional capabilities to create new value and maintain its competitive advantage. In this case, competition came not from toy manufacturers but from other forms of entertainment—video games, television—that threatened Lego’s customer base. To stay ahead, the company decided to participate in this new trend—by making movies, TV shows, and themed video games—while capitalizing on its strengths, such as manufacturing and branding. “The key,” Mazzeo says, “is to leverage existing capabilities while also determining how to be successful in a new area.”

Advantages Are Relative

Equally important is understanding that every competitive advantage is relative—and possibly temporary. “Companies should look at changes within their industries as touchpoints for making better decisions,” Mazzeo says. This approach leads to a more focused strategy than trying to read the zeitgeist. “If you’re not attuned to the underlying economics of your industry, you’re just left guessing what the next trend will be, and that is a fool’s game.”

For Mazzeo, any strategy must acknowledge that distinguishing oneself from the competition requires critical trade-offs. This is something even the most successful companies struggle with. Take Dell, for example. “We used to think of Dell as this paragon of everything that’s right about strategy,” Mazzeo says. “And now they’re almost an afterthought.” The company had perfected serving customers in the PC market and found itself in trouble when consumers shifted toward smartphones and tablets. “Serving your customers really well can be a double-edged sword,” Mazzeo says, because you might be missing opportunities to serve other customers in an ever-evolving competitive landscape. Dell’s dominance of the PC market eventually came at a cost.

There will always be tension between finding new growth paths and serving one’s current customers well. The challenge for business leaders, then, is deciding when to divert resources to explore new opportunities. “From a corporate strategy perspective, one of the most important things the CEO does is figure out where in his or her company to invest,” Mazzeo says. “The ability to match existing resources with new opportunities is one of the things that distinguishes the best CEOs.”